Ironically, to some, Penny Stocks are the equivalent of gambling due to their volatile nature. But what are Penny Stocks?
You might have heard the term but have no idea what it is or how it differs from quote-unquote “Normal” stocks.
Well, In this article, we’re going to look at “Penny Stocks” and determine how they might or might not be something you’d like to invest in. Let’s go!
What Are Penny Stocks?
So, in a nutshell, Penny Stocks are stocks that trade for $5 or less. They’re typically traded over the counter or OTC, which means they aren’t listed on a major exchange like “Nasdaq” or the “New York Stock Exchange.”
Penny Stocks are considered riskier than other investments because they can be volatile, and prices often mean higher risks and more significant rewards in terms of profits if your investment does well.
You may also have heard that ‘Penny Stocks are Speculative Investments,’ but what exactly does that mean?
According to 'Investopedia,' Speculative Investing is "the act of putting money into financial endeavors with a high probability of failure."
It means you’re trying to get super high returns from investments that could go one way or another. Some liken it to gambling, but it isn’t quite the same since there is an element of research and educated decision-making at play. However, the inherent risk is still very high.
Imagine you buy a stock in the “Investocker Gold Mining Company.” It’s hard to know whether this company will find a viable gold mine. Through your research, you may buy the stock on a hunch if you believe that the company might strike it rich. It is speculation.
Another attribute of speculation is that they are often held for short periods, and speculative investors typically move in and out of positions quite often. The key to being effective with speculative investing is that research is vital.
Are Penny Stocks Risky?
Penny Stocks’ risk comes from infrequent trades, a lack of information on the companies, and the challenge of buying or selling the stocks. Primarily since many are not even traded on significant exchanges.
For example, many Penny Stocks do not have a bid-ask spread, which is the price difference between when you want to buy and when someone wants to sell.
So, if you’re looking for a specific stock and cannot find it in your search engine, it denotes that it doesn’t exist.
Penny Stocks’ volatility also makes them unsuitable for long-term holding periods due to their high risk associated with small capitalization companies without established track records or earnings history.
Things To Keep In Mind Before Investing In Penny Stocks
If you’re thinking about investing in Penny Stocks, there are some things to keep in mind.
First, most of them are less than $5 per share, putting them in the “Micro-Cap” category. If a stock trades at $2 per share and has no debt or other liabilities (such as royalties), it’s considered a “Micro-Cap.”
Micro-Cap companies tend to trade on the over-the-counter (OTC) market rather than on major exchanges such as the New York Stock Exchange or Nasdaq. And those can be more challenging environments for investors because any government agency does not regulate them like these larger markets are.
Second, don’t expect much liquidity when buying these stocks! You may find yourself waiting days or weeks between placing an order and your shares arriving in your account.
That’s because these stocks do not have enough volume to support an efficient market system where prices move smoothly up and down based on supply and demand.
So while they may look cheap compared to other stocks today, don’t expect that discount to persist indefinitely; it’ll probably go away almost immediately.
Risk & Reward Of Penny Stocks
So, before you invest in Penny Stocks, it’s essential to understand the trade-offs between risk and reward that come with penny stock investing.
Penny Stocks are risky investments because they’re often thinly traded and may not be listed on major exchanges like the “New York Stock Exchange” or “NYSE.”
Fewer investors will be trading these companies, which can reduce liquidity and make it difficult for traders to buy or sell shares at market prices.
In addition, many companies don’t list their stocks on an exchange—they create their markets through direct contact with investors via phone calls or emails.
Because of this lack of transparency about where these shares are being held and traded within various markets, no official records show how many shares exist, making it difficult for investors who want to get out quickly.
Indeed, Penny Stocks are a little confusing and not for the faint of heart. They have significant risk, which also means potentially great reward, but whether you take a chance on them depends on if you are someone who can tolerate that level of uncertainty and risk.
I like to employ what I call the “Lazy Investing” strategy, which allows me to have a portfolio that is well-balanced and poised for profit.